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Rebate noir

Few people in financial services can be unaware of CP121, which looks at the distribution of financial products in the UK and especially at depolarisation. The paper proposes that designation as an IFA must be accompanied by remuneration under the terms of a defined payment system.

The remuneration that the IFA receives from his client must not be product-dependent. The IFA can receive commission but this must either be rebated to the client (if the full fee is paid separately) or, if the commission is set against the fee due, any excess of commission received over the fee due must be rebated.

No doubt, flexible commission payment systems exist to overcome the need for rebating, with the product being enhanced instead. However, the tax implications of rebating will need to be considered by IFAs and clients alike.

It is essential to start with Inland Revenue statement of practice 4/97, which deals with the taxation of commission, cashbacks and discounts in relation to the supply of goods and services and replaced SP5/95. In providing this analysis, I am indebted to my colleague, David Redfern, at Technical Connection.

Issued in March 1995, SP5/95 set out the Revenue&#39s view of how commission should be taxed if rebated to a client. It applied to life policies, annuities, capital redemption policies and personal pensions. The Revenue stated that it was also to apply to executive pension plans and FSAVCs.

But SP5/95 was widely criticised because its broad thrust was that any commission rebated to an ordinary client was subject to tax in his or her hands under Schedule D Case VI unless a discounted premium was paid as a result of an agreement between the product provider and client. An ordinary client meant one who was not an agent of the product provider paying the commission.

In October 1995, the Revenue announced it would be “inappropriate to tax ordinary policyholders on commission rebated to them”. This meant that commission either rebated or added to the policy by way of an enhanced allocation or netted off (where the client pays a reduced contractual premium because entitlement to commission is set off against it) is not subject to tax.

In announcing this “partial change of view”, the Revenue promised a revised statement of practice. This was issued as SP4/97 in November 1997.

In March 1996, the Revenue also announced that cashbacks given by banks and building societies as an inducement to take out a mortgage would not be subject to capital gains tax.

SP4/97 deals with commission, cashbacks and discounts in relation to the supply of all goods and services including, for example, collective investments and not just insurance and personal pensions although special additional provisions are needed for these products. The main thrust of SP4/97 is that, in general, ordinary retail customers buying goods, investments or services will not be liable to income or capital gains tax in respect of any commission, cashback or discount received by them. Unlike its predecessor, SP4/97 provides guidance as to the deductibility for Schedule D purposes of commission, etc, passed on to clients.

In this and subsequent articles, I will attempt to set out the position with regard to commission, cashbacks and discounts. But before we look at these taxation issues, it is worth reminding ourselves that commission can be used for a client&#39s benefit by:

Actual payment to the client.

Being netted off.

Enhancing the investment,

Discounting the price.

Any commission paid to an IFA will be assessed as income under Case I or II of Schedule D. Some of the commission paid on an IFA&#39s own policy may be ignored. Commission passed on to a client will normally be deductible for tax purposes. So, if all commission is passed on, the IFA&#39s tax position will be neutral.

Ordinary retail customers will not be assessed on commission passed back to them but SP4/97 does not deal specifically with trustees.

There are, however, some special provisions to consider.

Otherwise qualifying life policies do not risk disqualification because of the policyholder&#39s commission entitlement.

For chargeable event purposes, premiums must be adjusted to take account of reinvested amounts and amounts netted off.

Tax relief for personal pensions and retirement annuities is based on the gross contribution (where commission is paid separately), contributions inclusive of reinvested amounts and contributions net of commission deducted from the contribution as appropriate.

Commission paid in respect of the reinvestment or transfer of funds within an approved occupational pension scheme must be invested by the trustee/administrator for the benefit of the members. If commission is paid to other than the trustee/administrator of an occupational scheme or personal pension scheme, it will call into question the approval of the scheme with potential tax consequences.

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